Buying a House in Cash vs Getting a Mortgage: Which is Best?

When you buy a house in cash, you will save yourself the mortgage interest that you would have had to pay if you got a mortgage. For example, say that you were looking at purchasing a $400,000 house and had the cash to do so, but you were not sure if you should get a mortgage or just use your cash.

For sake of example, assume that you were able to obtain a 30 year mortgage at a 5% mortgage rate. During the course of the loan, you would pay $298,418 in interest if you were to put 20% down on the home. If you were to simply use cash, you would save yourself almost $300,000 in interest.

Additionally, if you are in the position to use cash, you won't have to go through the headache of getting a mortgage and you will likely be able to beat out non-cash buyers since you readily have the funds available to buy the home fast from the seller.

On the surface then, buying a home in cash seems like a good idea. You will save hundreds of thousands in interest payments and be able to compete in competitive housing markets. However, don't jump to the conclusion that cash is always best as getting a mortgage may be more beneficial in some scenarios.

You need to understand opportunity cost when considering whether to buy a house in cash or get a mortgage. When you buy a house in cash, you save interest that would have gone to the bank. However, if your cash could earn more interest elsewhere, it would be better to get a mortgage.

For example, let's say that you have $400,000 in cash to put towards a home. You are able to get approved for a mortgage at 4%. With these numbers, you would pay $229,982 in interest over the course of a 30 year mortgage if you put 20% down on the home.

Buying a home in cash may look like a good idea then as you will save yourself this interest. However, it is not a complete analysis. What would happen if you got a mortgage instead of paying cash for your home and used that cash elsewhere?

Assume that you are still going to put down 20% when you get a $400,000 mortgage. We are also going to keep the assumption that you were able to get a mortgage at 4% over 30 years. This would leave you with $300,000 in cash to use.

You decide to invest this cash in the stock market and leave it there over the course of your 30 year mortgage. Assume that you can get a return of 8% from the stock market during that time. At the end of the 30 year period, your stock portfolio would be worth $3,220,000 using the assumptions above.

By buying your house in cash, you would cost yourself $3,220,000. The argument against this is that by buying a house in cash, you will no longer have a mortgage payment which will free up your income for investing.

Let's look to see if you would be in a better spot by doing this. Your mortgage payment with a $400,000 home at a 4% rate with 20% down would be $1,952 per month. If you were to pay cash for this home, you would now have $1,952 per month to invest.

Now that you have a paid for house, you decide to invest the $1,952 that would have gone to your mortgage each month into the stock market. Assume that you can get an 8% return over a 30 year period. At the end of the 30 year period, your stock portfolio would be worth $2,653,545 with the assumptions above.

At the end of 30 years, you would be $566,455 poorer when you pay cash for your home instead of getting a mortgage. You can find this number by subtracting the value of your stock portfolio when you bought your home in cash ($2,653,545) from the value of your stock portfolio when you got a mortgage ($2,653,545).

As proven by the example above, it is a bad idea to buy a house using cash if your money can be better utilized elsewhere. In general, if your money can work harder than what your mortgage rate is, it is better to get a mortgage and get the rest of your cash working for you.

Before jumping to the conclusion that buying a house in cash is best, ask yourself if there is a better use of your dollars? Can your money earn more from investments? Are you trying to accomplish other financial goals? Do you have true high interest debt you need to pay off?

Up until this point, we have illustrated that you should get a mortgage instead of paying cash if your money can be utilized better elsewhere. However, what if a mortgage would cost you more than it would to pay cash for your home?

If your mortgage is at a higher rate than what your investments could earn, it is better to pay cash and then use the money that would have gone towards your mortgage to invest. For example, say that you were going to buy the same $400,000 home with 20% down, but this time at a mortgage rate of 8%.

Assume that your investments would only be able to earn 6%. If you were to get a $400,000 mortgage with 20% down and invest the remaining $320,000 that could earn 6% over time, you would have just over $1.8 million worth of investments in 30 years.

Since your mortgage is more expensive than what your cash could earn, it makes sense to pay cash for the home. However, once you do that, you need to repay yourself the interest you lost out. By paying cash for your home, you lost out on the opportunity to invest the cash.

Even though you no longer have a mortgage payment, you need to act like you do and pay yourself back the interest you lost out on. You want to act like you have a mortgage payment at a 6% mortgage rate as that is what your investments could have earned.

When you pay cash for your home, you are going to act like you have a 6% mortgage payment, which would be $2,343. You then want to take this money and invest it. If you can get a 6% return, you would have just over $2.2 million worth of investments. In this scenario, you would be about $400,000 richer by paying for your home in cash.  

One of the reasons that some people like to pay cash for a home is because of equity. You will often hear things like. "paying off your house raises your net worth." While this is technically true, it's not that well thought out.

The reason for this is because of accessibility. Homes are not like bank accounts that you can link to a credit or debt card. In order to get access to the value of your home, you can sell it, or you can borrow against the value of the home.

Chances are though if you are a cash buyer you will not believe in doing this. The point here is that some people always believe that paying cash for a house is a good decision as it relieves you of a monthly payment and helps you build wealth.

However, think about it this way. If you have $400,000 would you like to be able to access it? If you dump all of that money into a home, it becomes much harder to access. This is especially true if your money can work harder for you than what a mortgage costs.  

Remember to ask yourself if there is a better use of your money before paying cash for a house. Can you invest it and earn a higher return? Do you want to accomplish other financial goals? Do you have safety nets in place such as an emergency fund and strong insurance coverage?

If you use cash to buy a home instead of getting a mortgage, you can impact your liquidity. For example, say again that you are looking to buy a $400,000 home with all costs included. If you have exactly $400,000 and dump it into a home, you no longer have any money left over for anything else.

What if a medical emergency arises? What if you lose your job suddenly? What if your vehicle breaks down? Before liquidating all of the cash you have to put into a home, you need to put safety measures in place to ensure you won't run into a liquidity issue.

Make sure you build a well funded emergency fund, which is 3 to 6 months worth of cash for unexpected expenses, and set that money aside. Also make sure you have strong car insurance, renters or home insurance, and life insurance so you don't have to go into your pocket to cover expenses related to these issues.

Contrary to popular belief, a mortgage is not real debt. But, you are borrowing money which is the definition of debt, right? Hear us out. Debt is any financial obligation in which the only way you can pay it back is from money you have to earn.

What in the world does this mean? Let's think through it. Say that you went out and got a credit card. You then used this credit card irresponsibly and racked up thousands of dollars in debt by not paying off your balance in full each month.

The only way you can pay off this debt is by using money you have to earn, such as your income from your job. However, does the definition of debt listed above still apply to a mortgage? In short, no. Why exactly is this?

There are two ways to get rid of a mortgage. First, you can pay it off. Secondly, you can sell your home. Since your home may build equity, you can sell it for more than what you bought it for. Since you can alleviate a mortgage by selling it, it is not real debt.

Now, when you sell your home you have a housing problem, but not a debt problem. The point being made here is that you do not have to worry about "mortgage debt." It is perfectly reasonable or more accurately smart to get a mortgage instead of paying cash for a home when your cash can earn you more than what your mortgage costs you.

The bottom line is that whether or not you pay cash for home or get a mortgage depends. If your cash can earn more than what a mortgage will cost you, it is better to get a mortgage. If your cash cannot earn more than what a mortgage will cost you, it is better to pay cash.

Remember that if you pay cash for a home, you need to act like you have a mortgage payment and repay yourself the interest that you lost out on if you were able to use your cash to invest. Also keep in mind that the value of your home is not easily accessible, a mortgage is not real debt, and buying a home in cash can impact your liquidity.

At the end of the day, how you buy your home is up to you. We have demonstrated that if you have cash available to buy a home, it is not always the best financial decision to do so. However, if you believe it is right for you, you can do so.